TIVP090 (Video): Adobe, Lululemon, PayPal – Are our Biggest Losers a Buy Now? w/ Daniel Mahncke & Shawn O’Malley

20:50Daniel Mahncke:And for everyone else, there's two ways you can join us. If you're interested, a general admission ticket gets you full access to the conference itself, a stock pitch presentation from Kyle and an intrinsic value portfolio with Daniel and me, plus guest speakers that we'll be announcing in the coming weeks. Or if you want the full experience, our VIP ticket package that gets you all day conference access, plus a seat at our Saturday night exclusive dinner with William Green and the rest of our inner circle community. And it will definitely be one of the more special evenings we host all year. So if you've ever wanted to spend a weekend talking shop with serious investors in the financial capital of the world, this is it.

21:33Daniel Mahncke:Find tickets in the full agenda at theintrinsicvalueconference.com. That's theintrinsicvalueconference.com. And if you'd rather join us as a member and get the conference plus the full weekend included, apply to the Intrinsic Value Mastermind at theinvestorspodcast.com slash mastermind dash application. All the links are in the show notes below. Hope to see you in New York.

21:59Shawn O’Malley:speaking about cutting losses let's go to our second loser that has actually just staged somewhat of a comeback at least a small one the average price of my personal paypal position which is the company that we're talking about has been in the low to mid 60s so i would actually be close to break even right now after the stripe and advent takeover offer unfortunately i'm not break even i sold at a significant loss and it also wasn't a small position for me especially in my personal portfolio. And it's quite interesting because I think this one carries a lot of lessons, at least in my opinion. And I learned a lot personally from this investment.

22:34Shawn O’Malley:We sold our portfolio position after earnings in February of this year, and it was only partly due to earnings and the numbers. It was also just because they fired the CEO, who was actually a big part of my thesis. And in the end, I think you can say that there were just too many red flags around the company. So to just maybe quickly recap the thesis, because it has been quite some time since the pitch, and it might also not be as straightforward as a Ludo pitch, PayPal is basically still the household name whenever it comes to payment companies. And that's sort of the baseline, right?

23:05Daniel Mahncke:And you see that whenever we look at how many companies have copied the PayPal model. MercadoLibre's payment arm, for example, is commonly called the PayPal of South America for a reason.

23:15Shawn O’Malley:It's always good if your company name is chosen to be an example all over the world. I mean, we sometimes talk about how Ubering is a verb in pretty much every market in the world. But being a household name in an industry that is subject to just constant change also means you're probably quite outdated. And that was certainly the case for PayPal. So when I looked at the company for the first time, pretty much exactly one year ago, I think, I thought I would look at it to sort of figure out, well, it's an outdated business that would slowly deteriorate and that's quite cheap and thus I wouldn't make it part of our portfolio.

23:49Shawn O’Malley:However, and maybe that's where the mistake started, I liked the business much more than I initially thought. I mean, PayPal had a new, somewhat new at least, CEO who came in just one and a half to two years earlier and he had a much more modern idea of what PayPal is supposed to be or should become and he first made sure that the low margin business was cut and that the core of the business, so the branded checkout, also B2B to some extent by now, and also Venmo, which is sort of a newer bet, they go back to being profitable. And at the same time, he grew the buy now pay later business quite fast and began building new initiatives like an ads business.

24:25Shawn O’Malley:And all of that seemed to work quite well. And after the cost cutting measures, revenue growth began to accelerate again, while margins also went up.

24:33Daniel Mahncke:There was also a lot going on with the agentic commerce side of things too, I believe. You had deals with perplexity and open AI, where PayPal became the first payment provider to be integrated into those LLMs and all that sort of news. That was very exciting.

24:50Shawn O’Malley:It was exciting back then. And this is also when the stock reached new multi-year highs. And it actually looked like the thesis was playing out even earlier than I expected. But then we slowly but surely started to see some yellow flags. And since I want to do this episode to sort of evaluate why and when things actually went wrong, I think this is where I would start. So on paper, things still look pretty great. And perhaps I would have made the same decision of buying PayPal today under the same circumstances of last year. I honestly don't really know still to this day. I think on one hand, I didn't go for a value play like PayPal since that and focused more on these quality compounder companies, perhaps in an earlier stage.

25:30Shawn O’Malley:So I'll talk Melly or talk DLocal, which we covered just a couple of weeks ago. On the other hand, though, many of our previous value plays that we did buy for our portfolio. So, you know, I'm thinking about companies like Crocs, but also Ulta Beauty and even Nike, where we also made a double digit return. They worked out quite nicely. So I'm still not quite sure whether I just totally want to turn my back on those sort of opportunities. But, you know, getting back to PayPal, between Q3 and Q4 of last year, several things made me question what exactly is going on. So the first one was the biggest one, communication.

26:04Shawn O’Malley:When you followed managers that were responsible for specific business units, they were always very enthusiastic and they had plenty to say. So Mark Rita, for example, was responsible for the ads business. He was very outspoken in talking about how the world thinks are going.

26:20Daniel Mahncke:Well, and Mark is also the one who built the highly successful ads business at another one of our portfolio holdings, Uber.

26:28Shawn O’Malley:And also for Amazon. So he certainly knows what he's doing. But weirdly enough, the C-suite of PayPal just stopped talking about the ads business at some point. And after enthusiastically announcing it earlier, and while Margrethe was still giving pretty promising updates, that was not only the case for ads, but it was also the case for many, many of the initiatives that they just announced a couple of weeks, a couple of months earlier. And at the same time, you had a CFO who still goes on my nerves, actually, and who repeatedly said in interviews saying how bad the macro looked and that it was basically a tough environment for the business to operate in.

27:03Shawn O’Malley:And, you know, if that's the honest assessment, I think that's great. And thanks for saying that and being honest to shareholders. But why do you agree to do what felt like half a dozen interviews back to back when you don't have to say anything about that? And mind you, most competitors back then, they didn't seem to have the same problems with the macro. And if you're the only one struggling with macro, well, perhaps it's not the macro after all. And maybe this should have been the moment to sell the position. I mean, it was still trading in the 70s to 80 dollars range at that point. So we would have even made a nice little profit.

27:34Shawn O’Malley:But PayPal was still valued so attractively with, you know, buyback yield of, I think even back then, about 10%. It just had a good Q3 earnings trend and also reasonable catalysts for the future because of all those initiatives that I just felt like overlooking some of those yellow flags.

27:49Daniel Mahncke:And then Q4 came. And not only were the numbers a negative surprise, but an even bigger negative surprise came and the CEO, Alex Chris, being fired. And so I took that as an admission that the new initiatives weren't working out as planned.

28:06Shawn O’Malley:Yeah, I think that had to be the message to our shareholders. And in hindsight, it's always easy to label these yellow flags we mentioned as red flags. But I don't know, I feel like selling could have easily been an overreaction to. I mean, when a company is as cheap as PayPal, news always skews negative, right? Just like analyst estimates, for example, they should give you usually an idea of what's to come. But if you actually look at them, most of the time, they just run behind the stock price. So when it goes up, they raise their price targets. And when it goes down, they lower them, and you see all sorts of negative news coming.

28:37Shawn O’Malley:And that's also what you saw with PayPal. That's what we saw with Adobe, Lululemon, all of those companies. And still, when the PayPal CEO got fired. It was clear that things didn't go well behind the scenes for at least a couple of months and the management team just, I don't know, them not mentioning the initiatives anymore. You know, Macro is blamed, although competitors don't experience the same headwinds. The CFO is talking another book than the CEO. It just all looks so different from a couple of months back.

29:03Daniel Mahncke:But what probably makes the PayPal case so interesting too is that the bear case has always been that even if these catalysts didn't work out, these new initiatives for the business. That would be a possibility. But so you had a cash printing machine buying back 10 to 15 percent of shares per year. And that is another way you can grow earnings per share and still had some of the best assets in all of payments. So either they would become a share cannibal, and that would drive some baseline earnings per share growth, or they would be bought out. And the second option is now a very real possibility.

29:40Daniel Mahncke:You have Stripe and the PE firm Advent put out an offer to buy PayPal for$60 per share. And at the time of recording, PayPal has already declined that offer, but that is maybe part of a normal negotiation process. So they may still be willing to sell, but only at a higher price. And considering that we could have recovered a relatively large chunk of our losses if we had held on and waited for this offer, would you say it was a mistake not to hold on to the position? Because I mean, the idea was basically that this very scenario playing out would be the margin of safety. And that was baked into the model.

30:16Daniel Mahncke:And it did provide a layer of safety.

30:20Shawn O’Malley:Yeah, I think it's a tough question. There are two ways or perhaps concepts to consider in my mind. So the first is the idea of opportunity cost, right? I mean, capital invested in PayPal cannot be invested in any other stock. And it sounds quite simple, but it's also consequential in investing. And since not only makes you question whether any given stock will outperform the market and therefore presents a better opportunity than just buying an index, but also whether there's another stock with maybe a similar risk profile, but a better potential return. So opportunity costs have essentially been why we did decide to sell PayPal.

30:55Shawn O’Malley:And I had a clear thesis in mind when buying the stock and I sort of knew which metrics and business units mattered most to me. And I had an idea of the progress that I wanted to see. And that thesis slowly deteriorated and eventually it broke. And while my margin of safety scenario, which you just mentioned, the PayPal acquisition, is now playing out, or at least it's in the process, I also knew that this would be much more of a gamble than my original thesis. Because as you mentioned, PayPal just rejected the bid valued at$60 per share. So perhaps it can get much more, but perhaps Stripe will just distance itself from the deal.

31:29Shawn O’Malley:And then you need to find a completely new buyer. And there might be one, But I think the point is, this has turned into a gamble now of when and at what price PayPal will be sold. And with that uncertainty, I felt like we probably have better opportunities to allocate capital to.

31:44Daniel Mahncke:And just for the sake of giving the whole picture, the argument for why you should hold on to positions like PayPal, but also Lululemon, is to trust that you bought the asset at a cheap enough price that in the long run, you will make your money back or make a profit one way or the other. And so it could be through M &A, it could be buybacks, or it could be because the business actually turns around with new management. And so the premise, to some extent, would be that it's incredibly difficult to compare one stock against another. And you might just be better off to simply try and trust your margin of safety outcome.

32:18Daniel Mahncke:And to be fair, what decision is the best also can depend on your personal situation, right? Daniel and I are in a position where we research dozens and dozens of businesses each year. And that means there's a high likelihood that we can find a business with better prospects and then redeploy capital at better returns. So there's very significant opportunity costs. And if you don't have the time to look at that many stocks, it might just make sense to hold on to the position rather than diversifying into something for the sake of diversifying and maybe de-worsifying your portfolio, as they say.

32:54Daniel Mahncke:And then another factor is position size. in my personal portfolio, PayPal was a really, really small bet, smaller than yours, for sure, Daniel. So I kind of just kept holding onto it because the stakes were a lot lower. And then I actually sold on the news of the takeover offer, meaning I was able to recover a chunk of my losses. And that was simply dumb luck. And sometimes that's just how investing goes.

33:18Shawn O’Malley:Another fact that also comes to my mind is whether you still add capital to your portfolio. I mean, portfolio we built here on the show doesn't get any new capital. So if we have 5 % invested in a stock, it is quite literally always competing with new businesses that we look at because adding to them means we have to sell another current holding. And that's sort of the nature of what we do in our portfolio here. And my personal one, of course, I do add new capital every single month. So by just not adding capital to one position while generally adding capital to others, I can change my portfolio composition quite substantially.

33:53Shawn O’Malley:And we can't do that with the intrinsic value portfolio. So we need to actually sell one position to add to another. And on that point, one position that kept winning all of these capital allocation wars in our intrinsic value portfolio has been Adobe. We added to our Adobe position and I had to look it up four times already. And I can also spoil that the first lesson we need to take from this is only double down when the stock is at least down 15 to 20 % from our entry price? Because we kept buying in the range from 380 to 315, which looking back at it might've been a bit too expensive.

34:30Daniel Mahncke:Yeah, it was probably early in hindsight. And I agree that we could have done a better job at dollar cost averaging into this company. To be fair though, Adobe was one of our first additions to the portfolio. And we started the portfolio with 100 % cash and only wanted to add to companies that we covered on the show incrementally. So we had this situation where we're sitting on a lot of cash for a while in the portfolio. So there's definitely some subconscious pressure, I think, to allocate capital and not just sit on 80 % cash or more for half a year or longer. And so when a company that I considered to be very high quality kept getting cheaper, I saw that as a better opportunity to allocate capital than to invest into other mediocre businesses that we didn't have the same conviction in.

35:18Daniel Mahncke:And so that is what I would argue for to you. And it's another one of those difficult realities of trying to manage a portfolio publicly and showcasing the entire process. You wouldn't necessarily feel the same pressure allocating capital quickly if it's just your personal account. But of course, if you're managing money for clients, you might feel the pressure even sooner. So I think I'm a bit more bullish on Adobe than you are, Daniel. And Adobe seemed significantly undervalued to me, even when it was trading at above$300 per share. And at that time, the setup was that we were looking at a company with a price to earnings ratio in the low 20s, an incredible margin profile, high returns on invested capital, very substantial chunk of the business coming as recurring subscription revenue, and then double digit revenue growth.

36:06Daniel Mahncke:And nothing about that has changed for the record. The only thing that changed is the multiple the market is willing to give to Adobe and the narrative surrounding Adobe, right? It went from 22 times earnings to 11 times earnings. And that's a great way to have the value of your position. So I think you've actually bought in in your personal portfolio later than I did, but you've also sold most of that position. So I'm curious to hear how you think about it and And whether you disagree with my thinking here, Daniel.

36:38Shawn O’Malley:I generally don't. I think what changed for me is looking at so many different SaaS companies and just realized that perhaps all of them belong somewhere on the too hard pile, at least the ones that I couldn't understand because I don't have an insight as a customer, for example. And obviously we use Adobe almost on a daily basis, but I also believe that we are not the sort of company that Adobe banks on for the next 10 or 20 years. We're not, you know, this huge sort of enterprise customer that they need to sort of keep as a customer to still make the returns, their investments worth it. And also just where they have an advantage over what AI can do.

37:13Shawn O’Malley:I feel like a lot of the tools that we use at some point, and it might be only 10 years ahead, there will probably be an AI tool. And maybe Adobe is the distribution for that, but maybe it's not. And I feel like there are so many just unknowable things about the future that it's a more difficult bet to make than just a year or two ago. And that sort of goes back to the point of understanding what the market sees in the company and whether one has a different view on that. It's a much better business, obviously, than PayPal and probably also Lulu ever were. And compared to those two, you don't see the disruption that everybody talks about when you look at the headline numbers.

37:46Shawn O’Malley:I mean, you just talked about it was basically only the multiple. If you look at both Lulu's and PayPal's stock chart, then you just layer the top line growth over it. You will see there's a pretty strong correlation there for both of those companies. That's just not the case for Adobe. Adobe has grown at about 10 % per year over the last four years, while the stock is down 70 % since then. Of course, top-line growth is not everything, but studies have actually shown that revenue growth is the best predictor for where the stock will be heading in the long term. So over a 10-year time horizon, about 70 % to 75 % of the stock performance can be explained by revenue growth.

38:21Shawn O’Malley:And the main fear, obviously, with these businesses is that exactly that revenue growth will slow down materially in the future due to changes that AI brings. And when that fear exists, the multiple collapses. And that's exactly what we have seen with Adobe, as you just said. And by the way, multiples are the best predictor for stock performance if you just look at a one year performance chart. So probably that explains most of, you know, why SaaS companies this year have been going down. although technically the headline numbers just didn't change. And I think to go on the more positive side, the bull argument for Adobe is that most of its business comes from enterprise customers that want to have full control over the creative outcome.

39:03Shawn O’Malley:And that can only be guaranteed with Adobe Tools and AI cannot do the same. So AI is always probabilistic, which we talked about a lot by now, and that won't change anytime soon, if ever, honestly. And the problems that I personally have the position, which is why I sold in the end, mainly come from two things. So the first is, what about all the customers that are not Hollywood studios or big creative studios? I just mentioned it, the TIPs of the world and maybe also ad agencies. I don't think ad agencies have the same sort of love for the creative process. And if they can use AI for a fraction of the cost, that's what they will do.

39:38Shawn O’Malley:And then second, if Adobe loses the top of the funnel, which are young professionals, that will be a big hit for the company as well. So for years, that's what built the sort of skill mode where young professionals preferred working with Adobe since that's what they have been trained on. Then lastly, and this is a point that one of our Mastermind members actually made and I think it's a good one. You got to ask yourself whether you want to bet against AI right now in the first place. And that's the argument for me against most SaaS companies. I think there is a good argument to be made that you should just avoid owning stocks.

40:12Shawn O’Malley:The market is punishing because of a potential existential threat. to either their earnings power, which then compresses the multiple, or their core product, which then goes to the revenue hit risk. And especially when that thread is driven by technological innovation, and we know AI is here to stay, won't stop getting better.

40:32Daniel Mahncke:That last point is very much inspired by historically how Buffett has looked at tech investing and accepting that there are these unknowns that could destroy the thesis and therefore wanting to look for one foot hurdles elsewhere is sort of the mindset. And yet that said, he just invested tens of billions of dollars in Alphabet. And we know that it was Buffett now and not Abel who was calling that decision, which is interesting. And basically, he's called his negligence of tech companies a mistake. So even Buffett is now realizing that the world has changed in important ways. And although I would say investing in Google was probably one of the safest bets on tech you can make.

41:17Daniel Mahncke:Prices are high, but boy, I mean, what a quarter we just saw from Google again. And so anyways, I'm glad that we will be able to talk about that one in our winter episode, because it's definitely more fun to revel in the successes. And we bought that one pretty close to the bottom and it made it our biggest position by far. And then it's worked out well. But looking at Adobe again, I mean, it's clearly not at the same quality caliber of Alphabet, of course. And yet, it still is the market leader in its industry by a very wide margin. And as you pointed out, there hasn't really been any deterioration in the financials.

41:54Daniel Mahncke:And obviously, this can be a slow process, as it was with newspapers back in the day, where it wasn't just immediately obvious that those would go out of business. But I still don't really see any meaningful signs of disruption yet, despite the headline numbers that look really great, you also have these AI native revenue numbers that have triple year over year. And Firefly's AI creative app is nearing$300 million in ARR. And so all that looks pretty good. And they're also fighting back on the lower end of things too, which you highlighted as a concern a minute ago. And so in their latest earnings call, they talked about this strategic shift to focusing more on freemium users, which comes with incurring more costs in the short term because you're providing a lot of AI credits that you're not charging for.

42:45Daniel Mahncke:But it also shows that they're fighting to retain users on the lower end in the longer term. So basically, they had shared some guidance with Wall Street where the market was expecting them to raise prices on freemium users sooner. And they've decided to push back on that. And again, I actually see that as arguably evidence of them thinking much more longer term than making short-term decisions that would help earnings next quarter or the following, but might ultimately undermine the funnel that they've created and the flow of customers into their business. And so we talked about the Alphabet comparison, and I actually don't think it's a totally off comparison to make because just like how I thought Alphabet as the dominant player in search was best positioned to integrate AI into search.

43:35Daniel Mahncke:And even though that wasn't a guarantor of success, it did give them a pretty competitive advantage. I also think that we shouldn't dismiss Adobe's positioning and their ability to deploy AI tools at scale too. They sort of have the first shot at doing so. If they don't do it well, they'll definitely lose market share to competitors. And with the point being, new technology does not have to be a threat to incumbents if they manage it well. And again, that's not guaranteed. There's lots of illustrations historically of companies that have failed to innovate around new technologies. But again, you do have this distribution advantage when everybody is already using your products.

44:19Daniel Mahncke:So if you can figure out how to bake in the newest technologies and tools into your products, then the risk of competitive disruption becomes much more minimal.

44:29Shawn O’Malley:that's exactly what we talked about last week off the record right i mean there are these probably huge advantages it might be the biggest advantages in the age of ai and that's simply distribution and adobe still dominates distribution in the creative space and probably the problem is that adobe feels more threatened by ai at least i would argue than alphabet ever has but we could easily say that with the hindsight bias again last year we bought google and there was certainly a lot of people who told us that's stupid search will die and they have no clue what they're doing in terms of AI. So it might just be the hindsight bias of me thinking that Google has not been threatened to at least the same extent as Adobe has.

45:05Shawn O’Malley:And one guy who would probably agree with that is Dav Cantissaria from ValueForge Capital. He used to hold Adobe and he sold the position. And he said something that I found quite interesting. So I just wanted to quote him here. He said, for now, generative AI actually helps demand for Adobe as the initial AI images and videos still need to be edited using the company's sophisticated software tools over the long term. However, we see a future where Adobe is rendered obsolete, except for the very high end use cases. Even if the impacts are many years away, we look to put our investment dollars elsewhere.

45:39Shawn O’Malley:And we could probably debate for a while. But as an investor, you just got to make a decision based on your assessment of the future. And I don't know what will happen. And personally, I don't know anyone else with a crystal ball either. I think one last thing that I just need to get off my chest when we talk about Adobe is the management team. I talked about the mistakes I made with, you know, not acting up on the yellow flags that I saw with PayPal. And now Adobe shows a lot of them as well. I mean, the CEO left recently without any successor. Then the CFO followed just weeks later. And now you see this major shift towards freeming users you just mentioned.

46:13Shawn O’Malley:So perhaps I'm just personally too scarred right now from, you know, that experience to overlook those things. I mean, talk about personal biases, but I feel like all of that is looking somewhat odd.

46:24Daniel Mahncke:You know, what strikes me now that we've gone through all three of these companies is that I didn't really notice it until we said it back to back. But in each case, the management team is really shaping changes to the thesis, right? Lulu pushed out its CEO in favor of interim co-CEOs while the founder was publicly at war with his own company. PayPal fired their CEO and then had a CFO that was openly saying very different things about the strategy. And then now with Adobe, you have this legendary CEO retiring with no named successor yet. And even if that's perfectly explainable by something as mundane as the fact that he was just getting older, he's already led the company for two decades, the fact that you have the CFO leaving weeks later really couldn't have been worse timing.

47:13Daniel Mahncke:And so a while ago, we did a presentation at our TIP summit in Montana about the learnings of managing this portfolio. And we talked a lot about management teams. And again, this just reinforces how important those variables are to me.

47:30Shawn O’Malley:What bugs me is that in any of these cases, the trouble at the top showed up before the numbers actually took a turn for the worse. Again, keyword hindsight bias, it might've been that business has actually performed well, and then the CEO left and started to get worse after that. And it might be that the CEO goes because the business is already deteriorating and he sees it while we don't. So we don't know that. But what I do know is that it's difficult to act on that because you would need to find these, what I mentioned before, alternative leading indicators to tell you in what direction the company is going.

48:05Shawn O’Malley:So for newspapers, such metrics were single corporate retail sales or maybe even household market penetration versus population growth because for a long time, newspaper penetration actually grew alongside population. And when that correlation stopped, It just proved that younger generations were no longer becoming their customers. And it could be very far-fetched. I got to admit that. But I don't know. To some extent, I see some resemblance here with Adobe's problem of getting this new generation of creatives onto its platform. And then other alternative metrics to look at, although getting that data will be incredibly difficult, might be the divergence between total seats and actual design agency output volume.

48:45Shawn O’Malley:So the ratio of paid corporate seat licenses, which is how Adobe makes a lot of its money, to the volume of creative assets produced. So, you know, if marketing agencies use external AI tools, you would at least get a sense of the potential future churn that you can't yet see just because Adobe has a lot of these long-term contracts. But anyway, I'm just spitballing some ideas here. In the end, Adobe is still a holding. I'm conflicted on it, but I also believe it is good value, although the momentum is not in its favor. and I think we shouldn't be too affected by the price we paid for this company.

49:18Shawn O’Malley:I think we just got to view it from today's perspective and if you do that you have a company trading at a forward PE of eight times. You still have phenomenal financials and many good reasons to believe it's a monopoly-like position on the creative enterprise market is actually sustainable.

49:35Daniel Mahncke:What we know for a fact is that the market rightly so is wary of turnover at the top of companies and And another yellow flag that we haven't pointed out today, but we should discuss is the lack of insider purchases too. Perhaps because you had these two at the top knowing that they would be leaving soon, and that's why they didn't make any insider purchases. But as the stock has gotten torn apart, management has been happy to deploy the corporate treasury toward buybacks, which to some extent is reassuring. But again, they haven't been as inclined to buy shares with money from their own pocket.

50:11Daniel Mahncke:And so if Adobe's business does decline long term, in this case, I probably wouldn't look back at the CEO's departure as having been the canary in the coal mine or maybe even the CFO's departure because he does have a background in the semiconductor industry and that space has absolutely exploded thanks to AI. So it wouldn't surprise me if he just simply had some FOMO and wanted to go back to the industry that he had spent the rest of his career in. But really, the canary in the coal mine might be the fact that there's this lack of insider are buying from the rest of the management team. That gives me some pause.

50:44Daniel Mahncke:And if I get really pessimistic for a moment, I could definitely see myself pointing that out as a learning lesson in a few years from now. And so I don't know if that's thinking with the end in mind, but thinking ahead about what we might see as a mistake. And so otherwise, though, everything is so far so good with Adobe. And by definition, I do think you need to have contrarian opinions about the market to outperform the market. And that might sound like sort of a lazy defense for clinging on to a company that we have some anchoring bias with. And I wouldn't necessarily disagree with that, but I think the indicators that are driving the stock down are so speculative at the moment relative to how the actual business has been performing.

51:25Daniel Mahncke:I certainly wouldn't feel good about heading for the exit at this point in time, but we'll definitely continue to watch this one closely. And, you know, if we see data that materially changes our assessment of what's happening with the business, as we saw with Lululemon, then we should definitely think about trimming or exiting the position. But for now, it definitely remains in the portfolio. Yeah.

51:50Shawn O’Malley:We'll talk about lessons and conclusions at the end of the episode, but I think I can still spoil one that I just had when I did the research for this episode. And I don't know why, but it seemed to me that by covering so many companies, but especially by doing it all publicly, you feel the need to stand behind your positions way more often. And that means that all the negative news that come out that usually as an investor, you might even should just ignore, at least when it's not fundamental, we still read through them and we still have a stance on it. and we still publicly defend the company.

52:21Shawn O’Malley:Also just accept that this is bad news and we might sell the company too early. So I feel like, and that sort of goes to our PayPal point, if we do have deep dives into a company and we do that and we know everything that's important, we might just got to put more trust into our decision-making and the same might go for Adobe. So I still feel very good about owning it. And sooner or later, I also in my personal portfolio will have a position again. It's more about what we mentioned today a couple of times, which is opportunity cost. I needed some capital and I sold Adobe, allocated that capital somewhere else.

52:51Shawn O’Malley:But over time, I will buy into it again. Okay, but how about for a change? We switched to a company where the CEO has actually doubled down massively since the stock went down instead of just leaving the boat. And we fortunately also didn't lose a single cent because we didn't invest in the company in the first place. Do you already have an idea of what company I'm talking about?

53:12Daniel Mahncke:Oh, I do. I do. you got to be talking about Trade Desk. And I'm very glad we didn't buy that one. I still remember when it dropped 40 % in literally the next trading day after we published the episode on a Sunday. And while we decided against it for what we now know were seemingly the right reasons, it's definitely fair to say that no one expected such a sharp decline. I certainly didn't imagine that it would fall 80 % from its highs.

53:42Shawn O’Malley:I actually listened back to the episode just yesterday. And the first lesson I want to do from all of this is only just to trust your gut feeling and even more importantly, stay within your circle of competence. I mean, we primarily didn't start a position because we just felt like the business was too difficult to understand. And to be precise, this is what you said in the episode back then. I feel like we should just put it out there.

54:04Daniel Mahncke:ttd is just a bit difficult for me to get comfortable with i'll be fully honest i was expecting for it to be easier for me to wrap my head around the trade desk after already having gone deep on alphabet and roku but ad tech is just so very messy and complicated i just feel like the ad tech industry probably goes in the too hard pile and the trade desk as a pure play on demand side programmatic advertising, you really need to understand the digital advertising ecosystem fully and technically kind of know what's going on behind the scenes to appreciate what makes the trade does valuable and what can make it less competitive in the future.

54:46Shawn O’Malley:But the second learning for all of us, including everybody who currently listens to this episode is don't blindly trust valuation models. It doesn't matter what that outcome of the model is. what you need to look at are the assumptions that you made to get to the outcome. In the model from back then, we still assumed a 30 times exit multiple because of the quality of the company. And the cash flow multiple today is just 10 times. So despite that, the model back then still showed that the stock was overvalued at the time. But the decision not to buy it didn't come down to what the model said. It was primarily us thinking that we don't understand the company.

55:23Shawn O’Malley:And again, if you will trust the valuation model, despite having a way too high of an exit multiple and still saying it's too expensive. Nowadays, just a couple of months later, the exit multiple is a third of what we assumed going out five years from now.

55:37Daniel Mahncke:And in preparation for this episode, I did go through our master file for the portfolio. And that's where we showcase our holdings and returns and have links to all the models that we've covered for all the companies on this show previously. And one of the things that looked that was how much of a discrepancy there's been for many of the stocks we covered from over a year ago between our estimate of fair value and what the current stock price is. And so the only bigger difference to the downside than with Trading Desk, meaning where our fair value estimate was much higher than the stock price today, that was Vital Farms.

56:15Daniel Mahncke:And so that stock has come down a whole lot too. But to your point, when your model says one thing, but your gut says another, I would typically, not to be too cliche, say that you have to follow your gut feeling there. If it makes you sick to your stomach to think about owning a business and you're only doing so because the financial model says that the stock is undervalued, that's really not probably going to be a very good decision to make. If you can't make a good qualitative case for owning the business, then And again, it doesn't matter what the numbers can say because the numbers can change in an instant.

56:49Daniel Mahncke:A couple percentage points, less growth or margin compression, all that can happen very fast. And so feeling comfortable with the decision qualitatively to me is the best proxy for whether you should own a stock generally. And then you use the models to kind of help guide your entry point and try to make an informed bet on the odds of success are really in my favor with buying this stock at this price if I'm going to hold it for the next five, 10 years or whatever it is.

57:17Shawn O’Malley:Comfortable in the sense of understanding the business, at least. I think there's something to say about being uncomfortable when you make an investment decision simply because of the sentiment or the perception of the market, of the business. And I think there are many investors who mentioned that the best investments were the ones where they actually felt the most uncomfortable. I think Howard Marks once said, if it doesn't make your stomach churn, it's probably not a great bargain. The best buyers are found precisely where the fear is the greatest and the future looks the darkest. You have to be willing to buy when doing so makes you feel physically ill.

57:49Shawn O’Malley:But then again, I think this is mostly going down to public perception, not about how comfortable you feel with the understanding of the business.

57:57Daniel Mahncke:So another interesting point in this trade desk story here was that there were actually massive insider buys a couple of months ago by the co-founder and CEO of the company, Jeff Green. And so in March, he bought stock on the open market at$25 for almost$150 million in total. And since then, the stock has fallen another 25%. And so it sort of complicates the signal we're pointing to with Adobe. A lack of insider buying is not guaranteed to be bad. And significant insider buying is not guaranteed to be good. But generally, though, they're pretty effective predictors. historical studies have definitely shown that insider buys have pretty strong predictive power and the trade desk may very well just be the exception to the rule and perhaps we'll look at it in a year from now and maybe things will turn around that does happen carvana went from the worst performer and the s &p a few years ago to the best the following year so it can happen but i'm certainly not itching to start a position in the company today just because it still follows in that too hard pile?

59:04Shawn O’Malley:We definitely tried. I mean, since you covered it, we've been asked many, many times whether we do not want to revisit it. And especially given the significantly lower prices today, whether it's not more attractive than it has been in the past. And another lesson that I've learned from my investing journey so far is that a lack of understanding mixed with deteriorating business fundamentals, which is certainly the case here, is the worst possible combination that you could find. If I don't fully understand every aspect of a company, but I get 80 % of it, and I add to that a mega trend or a major positive tailwind, it can still work out quite well.

59:36Shawn O’Malley:But in TTD's case, you have a business where top line growth is continuously coming down. I mean, Q1 of 2024 was 28%. In Q1 of 2026 was only 12%. Then answering the question of what that company is worth today is so much more difficult. The trade desk is likely a bargain today if we can assume that 12 % top line growth is what we're getting for the next five years, assuming a similar margin. But how should I underwrite that assumption if growth more than halved in just the last two years? And if you're an ad tech expert, that might be totally different for you. Maybe you understand the business significantly better.

1:00:11Shawn O’Malley:I'm not saying that the trade desk is bad value right now. But for us, it's just in the too hard pile. It was there last year, and it's still there today. And I have pretty high confidence of saying it will most likely be there next year, too, even if it's at, I don't know,$5 per share.

1:00:27Daniel Mahncke:If anything, my surprise at how dramatic the sell-off and the trade desk has been made me feel like I understood the business even less than I thought because it has been such a quality compounder for such a long time that I wouldn't have thought that things could go this bad this quickly for the stock. So anyways, that just shows probably how poorly I understand the business and that there are definitely easier hurdles for us to clear.

1:00:56Shawn O’Malley:we gotta admit quality company bros did not have a good one and a half years recently and we could just you know keep going in that direction and talk about another business that is currently in our portfolio and is down about 25 percent and that's costar group and i should say that for this company it's not so much about figuring out any patterns today because it hasn't spent that much time on our portfolio so you know i believe the price decline is mostly just volatility and momentum. It was going down the entire year. It continues to go down. And yet, maybe there are some things that have changed and that we should cover.

1:01:30Shawn O’Malley:So yeah, I figured we should just talk about CoStar, which you pitched about three months ago now. And since it might be a bit less known to our audience than some of the other companies we talked about previously, you might just want to give a quick pitch on why CoStar seemed so interesting to you.

1:01:46Daniel Mahncke:Yeah, it's still really early in the CoStar thesis. It'd be way too soon to write it off in one direction or the other. But really the way to think about CoStar is that it's the Bloomberg terminal of commercial real estate. So it's this data business empire built over 40 years of research and physically visiting and cataloging properties. And that gives them a monopoly-like grip on the comps and analytics that brokers and lenders and investors all depend on in this industry. And so that core data franchise carries about 50 % margins. And the business overall has a net cash balance sheet, and then has strung together something like 60 quarters of double digit revenue growth.

1:02:28Daniel Mahncke:So it really is an impressive business. And so the controversy and the reason the stock is down so much boils down to management having plowed billions of dollars into homes.com, which is this residential portal meant to challenge Zillow. And most people are probably familiar with Zillow if they don't know what homes.com is. But that investment has dragged the entire company's operating profits negative. And then actually it drew in an activist investor who was advising for change and Dan Loeb, who's a pretty famous investor. So the thesis is basically that the market is so fixated on the cash burn tied to homes.com that it's handing you this crown jewel commercial monopoly data business at a discount.

1:03:13Daniel Mahncke:And for lack of a better words, the expression is throwing the baby out with the bathwater is really what it seems like has happened here with CoStar.

1:03:24Shawn O’Malley:The briefest explanation of what happened is it's a SaaS company. And that might explain why I just can't catch a break right now. But I think the investments into homes.com had already slowed down when you made the pitch. So they are still burning money there, but at a much slower pace than they used to. And I got to admit that when you first pitched CoStar to me, I was a bit overwhelmed by all the different business units and some other yellow flags, which were mainly about market share numbers that sort of seemed a bit weird to me. They were quite low, although it is technically a monopoly.

1:03:55Shawn O’Malley:And then the CEO also has a pretty low ownership stake. And also the fact that the CEO seems to have a history of massive spending in order to win market share, all of that didn't help. Although to his credit, it worked out in previous endeavors. But that could also be why he is just too stubborn today to see that this fight is lost, if it is. I mean, even Dan Lope, the activist investor who came in, has already left the company. And while the public statement was quite brief, I think it became clear that he just didn't believe he could have any impact on the CEO, Andy Florence, and or the direction of the company.

1:04:28Daniel Mahncke:If I were to sort of assume the perspective of CoStar's CEO, I think part of what makes giving up on this bet so hard is that Zillow is such a dislikable company. They really have some uninspiring business practices and have incurred lots of lawsuits for how they've run the company and lots of allegations of theft and stealing from CoStar itself. So there is a pretty bitter rivalry between the businesses. And actually, Zillow has not performed well as a company anyways. So it feels like things are really ripe for disruption where CoStar should be able to come in and just take over that business.

1:05:16Daniel Mahncke:But of course, there's a massive amount of brand recognition working in Zillow's favor that makes it easier said than done. And so, I mean, it does give me some pause to see somebody like Dan Loeb lose faith in the co-star thesis where he was primarily arguing to cut spending on homes.com. And there definitely is some thought of this maybe being an ego thing where, like I said, there is a pretty bitter rivalry between Andy Florence and Zillow. And it may simply boil down to not what is the best economic decision, but a sense of pettiness and wanting to take down sort of an enemy. And so all that said, CoStar has decided to drop its net investment into homes.com from$850 million last year to what will be about$300 million this year.

1:06:11Daniel Mahncke:And then in 2030, it's supposed to come down another$100 million. So even if the cutback in spending was not to Dan Loeb's liking, there is a cutback occurring, which gives me confidence in not just writing off the entire business and definitely going forward, especially when the valuation stripping out spending on homes.com is so reasonable for a business with the data moats that CoStar has that are built literally by photographing thousands of commercial real estate buildings across North America over several decades. So we do know that the worst case scenario of them just blowing everything on homes.com is very unlikely to come to fruition as they already cut back spending.

1:06:56Daniel Mahncke:And like I said, with this data moat that they've really built one building at a time, AI can obviously not replace that. And so the other thing that Dan Loeb has criticized that maybe deserves some attention from us is Andy Florence's pay package of$40 million a year. And I think he does have a good point there. It probably didn't help their relationship though, that he was suggesting that Andy makes too much money. So in the end, it to me comes down to this being a story about valuation. And it has become pretty absurd how much negative value the market is ascribing to homes.com. The entire investment cycle costs CoStar about$3 to$5 billion, depending on what you consider as solely being an investment in homes.com.

1:07:41Daniel Mahncke:And yet the market cap, however, has gone down from $40 billion to$11 billion. So it's done a lot of damage. And this is a very rough calculation, since you also have to account for the fact that CoStar traded at a premium multiple, that the market is just simply not giving to SaaS companies these days. But again, And the point is that homes.com investment is not even remotely as impactful on the actual financials and prospects of the business going forward as the stock market is probably making it seem, or at least that would be my opinion.

1:08:16Shawn O’Malley:You mentioned earlier the presentation that we gave in Montana for our TIP summit. And part of that was also understanding the importance of the market's narrative about a stock or a company. And I can only feel confident in my decision about a stock when I do feel like I understand what the market dislikes about the company when I look at it. And then when I have a different opinion and I have good reasons to believe that I'm right. And only then can I figure out personally whether that makes sense to me to invest into this stock. And I got to say, in this case, it's clearly homes.com what the market is barked about.

1:08:46Shawn O’Malley:However, I think the market is also looking beyond that. And it's just generally questioning whether they will ever see any of the cash flows that Costa produces. And still, the more I looked at it, the more I felt like this is a massively mispriced opportunity. So I actually got away from my research here feeling way more confident in it than I was just a couple of weeks and months ago. I've did some math and you just pointed out some of the points. The value that Costa lost just because of this Homes.com bet and the spend is not that massive is ridiculous. I think if you would have to give Homes.com a negative value just to make sense for the market cap to drop that much, it would be in the tens of billions almost.

1:09:25Shawn O’Malley:So I do believe it's way more mispriced than I first thought. And when I asked you about a week ago, you didn't seem to be worried either. So it was probably only me who needed more convincing anyway. And I think the fact that the stock is so much cheaper now, it certainly helps with that.

1:09:40Daniel Mahncke:If I were going to recommend adding more to either our Adobe or CoStar positions at current prices, both are attractive, but I would probably prefer CoStar. Oh, wow.

1:09:51Shawn O’Malley:Well, actually, then should we add to it? I mean, if you like it more than Adobe, it should probably be at least a bigger position than 1.5%. And again, like part of why it's so small is that I wanted to get more comfortable with it. And I feel like I've done that. And especially now that it's lower. I mean, again, we've lost 25 % from our entry price. I got to say, I feel a lot better about the opportunity here. So what do you think about maybe pushing it up from 1.5 % of the portfolio to maybe 3 %? then?

1:10:20Daniel Mahncke:We've got the cash to do it. So I don't see a reason not to. And we are already learning some lessons from our mistakes in the past, right? With Adobe, I think we said not to double down on any positions and so we've had at least a 15 to 20 % loss, which is sort of arbitrary. But the fact that we're down 25 % lower and you're more comfortable with the business than when we first pitched it. Yeah, I definitely would be happy to increase its weight in the portfolio.

1:10:46Shawn O’Malley:All right. Sounds like we have Even made a portfolio decision today, which I didn't intend to when I started this episode. But having that and discussed most of the companies that I wanted to go through today, how about we go to some of the learnings from this? We already mentioned some of them going through the episode, but I still think there's some stuff that we can talk about. And I think the difficult thing about investing, and we learned that also in today's episode, is that every investment is just different. You can point out all the yellow flags of PayPal, and then you compare them to what we see with Adobe.

1:11:16Shawn O’Malley:and if the Adobe investment fails, you can easily say that it was so obvious and we didn't learn anything from our PayPal mistake. But on the other hand, you can analyze a Google investment, which was also done during peak negativity and it turned out different. So I think it's very difficult and that's why so few people can sustainably outperform the market.

1:11:37Daniel Mahncke:You just never know what'll happen in the short term and that's why value investors try to buy companies where even the worst case outcome is still tolerable. I think PayPal is a pretty good example of that with this potential acquisition now and how that factors into what we thought was our margin of safety at the time. And I also wouldn't be surprised, again, if we saw something similar with Lulu, where if you actually held the stock for five years from today, I would not be surprised if things ended up being okay. But the question is just, are you willing to ride out those losses after things have already changed pretty dramatically?

1:12:16Daniel Mahncke:Or are you just going to hold on to something for the sake of, hey, I said I had a five-year time horizon, so now I'm absolutely going to hold on to it for five years. And maybe at the end of five years, I'll break even on it. That's not necessarily the best investment approach either. And so I don't know if it'll be an acquisition for Lululemon. Probably not. But certainly there could be a shift in sentiment, business fundamentals, especially as they continue to grow in China. And then that could all change the valuation dramatically. So it's not like you make the decision to buy or sell a company and then time just stops, right?

1:12:48Daniel Mahncke:These businesses continue to operate and continue to keep trading. And so you're continuously having to make subconscious and conscious decisions about owning or not owning different businesses. us.

1:13:00Shawn O’Malley:I think what I like most about our discussion today is that it shows a bit more how conflicted we can also be about the positions in our portfolio. Just because we own a company doesn't mean there's nothing negative we can point out. And the two of us, and three of us, if we include Kyle, can have different opinions on those companies too. I mean, we obviously know you would have never bought PayPal and I would have never bought Lululemon, but that's life when we manage a shared portfolio. The same also goes for the winning bets. I always like to mention Reddit as an example. I wasn't sold immediately and yet it turned into, I think, our most successful pick and it's also part of my personal portfolio.

1:13:34Shawn O’Malley:So we just learned from each other. And I think something else that I liked about this episode is that it sort of made me reflect on all the decisions that we made as investors, but also as investors who publicly share their portfolio and their decisions. I learned that there's a huge difference between managing your personal portfolio and then also putting it out into the public. And there's so many new biases that you have to sort of tackle and so many mistakes that you can make because of that, right? I think one of the lessons for me certainly is to be maybe a bit less active. I think we had to do that to some extent in the last year because we had to deploy so much cash.

1:14:09Shawn O’Malley:But now that we have a more or less finished portfolio, and obviously it's never finished, it's always in process, but we have 15 to 16 positions, which is what we initially aim to. And I think having that, we can just be a bit more calm about finding new companies, actually comparing them to the companies that we have. And then also when in doubt, might just give a bit more credit to the companies that we own and not react to all the negative news that are coming out. So there's obviously a lot to say about PayPal and Lulu and all of those companies, but we bought it because we researched it for a lot of time.

1:14:43Shawn O’Malley:we also learn more about them while we own them. I think that's an underrated point that you can only understand so much about a company when you actually do the research. You learn so much more when you actually own them for a couple of months in your portfolio. You sort of understand what news are coming out, how the shareholder base is communicating to each other, how the CEO is communicating, not only in earnings calls, but also in between. And I think personally, not reacting too much to negative news, trusting in the process, and also acknowledging that while we look at those companies again and again, we're building a portfolio for the long term, right?

1:15:17Shawn O’Malley:So having so much turnover in just one year also shows that we probably should sort of zoom out more often and look at what actually is changing within those companies and especially for the long-term thesis. And I probably also feel that we should do more of these episodes more often, not necessarily talking about our biggest winners or biggest losers, but just revisiting investments and discussing how our thinking evolves. Since we do that every day in the Mastermind community, it can easily feel like we are already constantly doing it, but we're not doing it on the podcast. And I feel like that's a different thing for the people who are listening, but also for the two of us, including Kyle.

1:15:52Daniel Mahncke:I definitely think we should have more of these reflections on our investments. I'm actually working on an updated episode for Uber, which we fortunately didn't mention today. It wasn't one of our biggest losers, but it has also given up some gains from when we first invested in that position. And yet, at least personally, I'm as bullish as ever.

1:16:14Shawn O’Malley:All right. Sounds interesting. So with all of that, I would say we call it a day. I'm glad we got through this without feeling too bearish on our positions. I actually, again, came across many companies where I felt like we probably look at them a bit too negatively just because of the price section. And they are way better businesses than we think. But with that, I think next time, again, Saturday, we'll look at the portfolio's biggest winners, which is a bit more fun. And I would say I just ended with a quote by Peter Lynch, who said, in this business, if you're good, you're right six times out of 10.

1:16:47Shawn O’Malley:You're never going to be right nine times out of 10. And I would say cheers to that and see you in the next one.

1:16:54Daniel Mahncke:Just a quick note before you go. This episode would not be possible if it weren't for our friends at Fiscal AI. It's our complete stock research terminal that Daniel and I use on every single episode and with every company we dig into, pulling 20 years worth of financials, digging into segment data, grabbing quotes from the latest earnings calls, and making use of real-time institutional-grade data all in one place. And if you want to try it yourself, well, head to fiscal.ai slash T-I-V-P. That'll include 15 % off if you upgrade to a paid plan. That's fiscal.ai slash T-I-V-P. Thanks for listening.

1:17:56Shawn O’Malley:performance is not a guarantee of future results. Listeners should do their own research and consult a qualified professional before making any financial decisions. Nothing on this show is a recommendation or solicitation to buy or sell any security or other financial product. Hosts, guests, and the Investors Podcast Network may hold positions in securities discussed and may change those positions at any time without notice. References to any third-party products, services, or advertisers do not constitute endorsements, and the Investors Podcast Network is not responsible for any claims made by them.

1:18:23Shawn O’Malley:Copyright by the Investors Podcast Network. All rights reserved.

1:18:55Shawn O’Malley:to swing. Today, after almost a year of building our portfolio, we will take a look at how things went and there's quite a lot of news today. We will sell one company, enter into another position and add to an existing one. So I would say stay tuned.